A law unto themselves

Claire Smith
Originally published in the May 2005 issue

Dechert stole a march on its competition when it formed the first transatlantic alternative investment funds practice in a law firm, back in 1997. Since then, turnover has grown year-on-year to reach £9m from a standing start, but a raft of other legal advisers have begun copying the strategy they once frowned upon.

Dechert has made quite a name for itself: "If you talk in hedge circles," says Ian Dyble, the head of product development at Cazenove Capital Management, "everyone has heard of Dechert, and of Stuart Martin and Peter Astleford. They stand out as the people to talk to." The question is whether such momentum can be maintained.

Astleford trained at Linklaters, one of the so-called Magic Circle of top six law firms in the UK. As a young lawyer he cut his teeth advising Global Asset Management on all its offshore fund business, not least on the movement of 22 funds from Panama to the BVI after the Panama invasion. In 1990 he jumped to Invesco, where he spent three years as group legal adviser and later head of corporate services before moving back to private practice.

In 1997, he was lured to Dechert, a law firm known for investment funds work in the US but with only a small presence in the London market back then. "At the time I had 40 clients, many in the hedge fund area," he says. "Dechert said come and build your business here with us in London, and I just thought it was an inspired idea. Nobody was targeting the investment management area at all then, saying we want to do your work on a one-stop-shop basis on both sides of the Atlantic."

How times have changed. Traditionally competing against Simmons & Simmons for work advising hedge funds in the UK and Europe, Dechert now finds itself up against a new breed of US law firms belatedly opening in London: the likes of Kirkpatrick & Lockhart Nicholson Graham, Schulte Roth & Zabel and Akin, Gump, Strauss, Hauer & Feld.

Dechert maintains it is still the only firm to dominate the hedge funds legal market on both sides of the Atlantic. The firm has seven partners in London in its financial services practice, a further 13 in Washington DC, and four more in each of Boston, New York and Philadelphia. There are others in Newport Beach, Brussels, Frankfurt, Luxembourg, Munich and Paris.

In the US the practice is 70% traditional mutual funds, 30% alternative investment funds and hedge funds. In Europe the reverse applies, and the practice focuses on the more entrepreneurial end of the market. Firmwide, according to legal publication The American Lawyer, in 2004 Dechert's fund clients had net assets of $462bn under management, ranking it fourth amongst US law firms. Dechert advised on 55 new issues last year.

The ability to advise funds on both sides of the world has proved an innovative USP. Though precise statistics are sketchy, something like $75 out of every $100 invested in hedge funds worldwide originates from US tax payers.

Astleford's partner Stuart Martin joined Dechert in 1997 from Baring Asset Management, where he had been in-house counsel with responsibility for investment funds since 1993. Before that, he too had practised at a Magic Circle UK law firm.

One of his first instructions was to advise Cazenove on its registration with the US Securities and Exchange Commission. He now sees the SEC-registration of non-US managers as a big issue this year. Historically the US market has been substantially less regulated than the UK: you currently only need register with the Securities and Exchange Commission if you have more than 15 US clients, with one hedge fund counting as one client. The Financial Services Authority requires registration if you have just one UK client.

As of the start of 2006, fund managers will have to count all of their US investors as separate clients, even though they invest through a hedge fund. They will have to look through the structure and identify the American investors in each of their composite funds. A whole raft on unregistered managers will be forced to apply for registration.

"The US regulators treat you the same whether you are UK or US-based," says Martin, "If your clients are US, you will need to register. We have done lots of US registrations, but for hedge funds you onlyused to do them in very special circumstances, now many UK money managers will have to register."

Martin and Astleford recommend funds begin the process by the Autumn, in order to be registered by the start of the year. "Even if a client says, 'I don't want any US investors in my fund', it may still be an issue," says Martin. "The investor may be a fund of funds investing in the client's structure, with only a few US clients. Before, the relative size of their US component would not have meant it was treated as a US investor, but that may be different now."

Astleford adds, "There are about 100 investment managers in the UK today, directly regulated by the SEC. Typically they have lots of US investors, not hedge funds. Going forward, that number could easily double, maybe even triple, made up now of this great new band of hedge fund managers who directly or indirectly have more than 15 investors in the US."

Historically, one of the clients that bought Dechert to London was EF Hutton & Co, once one of America's largest brokerage houses before it was sold to Citibank in 1988. The law firm's client base has blossomed since, largely on the back of the hedge fund industry. One early client of Astleford's was Sloane Robinson Investment Management, while others which similarly started out as boutiques and are now institutional clients include ABN Amro, American Express, Gartmore, Tokyo Mitsubishi Asset Management, and Framlington.

Also on the client roster is Boyer Allan, Kairos, Cambridge Place and FPP, which has a range of investments in emerging markets. Work for investors includes acting for Railpen, Skandia and a number of Swiss family offices.

Martin's first client was Thames River, which was set up by a group out of Barings. Others include Cheyne, which like Cambridge Place does a lot of CDOs, plus Tilmey and Artemis. Major players include Hermes, Barings and La Fayette.

Though there are clearly more established legal advisers to the mainstream investment funds market, Astleford and Martin pride themselves on growing up alongside the alternative investment boutiques. "We found they were generally young, very entrepreneurial, very bright, and trying to change the world," says Astleford. "Early hedge fund managers didn't have legal departments, so we would get involved in everything they did. And we had an offering that as a formula was exactly right for the alternative industry. We all really liked doing the work."

From day one the practice has broadly added a new client every week, growing revenues by about £1m a year in Europe. In all, the investment management group accounts for 17% of the firm's global turnover. In London, the pair say that half of every £10 billed comes in through one of their personal connections, a further 50p comes from the US, and the remainder as a result of referrals, recommendations and selling the transatlantic package.

Last year the team advised Gartmore on the launch of three new AlphaGen hedge fund products, and advised American houses on co-ordination of fund registrations in Europe and Asia, including American Express Luxembourg and Scudder Global Opportunities Fund.

There is no doubt the legal market is getting increasingly competitive, as many other law firms wake up to the opportunities for advising hedge funds. Ian Cadby, executive director of Liberty Ermitage Asset Management, says, "If you go back three years, there were really only two law firms that had carved out a niche in hedge funds, and that was Simmons and Dechert. At one point I remember reading that between them they had 65% of the market. In the last three years there have been quite a few US law firms entering the market."

He says Dechert still has some advantages though. "The others all offer the same degree of competence as the Dechert guys. We still use Dechert because we have formed arelationship, and we are really happy with the quality of their work. The strength they have is that they have been dominating the market for a long time, so the experience you get when you are asking for an opinion on a structure or an innovation, that's what makes us sit up and take notice."

Though no longer alone in the transatlantic offering, Dechert does still offer a broader service on the ground in London than any other firm with a US presence. The firm merged with UK firm Titmuss Sainer Webb in 2000, after a six-year alliance, and though the link-up added little on the financial services side, it did add significant resource.

Martin says, "By being full service in London we are able to provide a client with a full legal service across the board. A client needs to talk to us not only about fund structures, but issues like employment, tax, everything you should consider when setting up a business. If you are an integrated firm you can pick up the phone and ask your partners about these issues whether in the US, UK or continental Europe, and it gives an added value to the client."

He adds, "Hedge funds themselves are becoming much more cutting edge, using new types of derivatives and new types of leverage instruments. All those require us to look at other structures and take into account other areas, talking to derivatives lawyers, tax lawyers, securitisation lawyers, debt capital markets, everyone."

Kirkpatrick & Lockhart merged at the start of this year with London's Nicholson Graham & Jones, and both firms will now focus on financial services going forward. The US firm is well-known for hedge fund work in the US, and here, like Schulte Roth, it now has the potential to pose a threat to Dechert's, and Simmons', market dominance.

Dechert hopes to set itself apart with its focus on the entrepreneurial side of the investment management business, but also by retaining strong links with the prime brokers that can influence the choice of legal advisers for new funds, and tend to favour the established names.

Still, competition is fierce, and other firms may boast stronger corporate and litigation back-up. Dechert has relocated a corporate finance partner, Peter Draper, into the financial services team to focus on deals for those clients, as it struggles to get an edge. Last year Draper acted for Mellon Financial Corporation on the £150m buy-out of the remaining stake in its Pareto Partners joint venture.

Astleford says, "The message you have probably got is that Stuart and I are technical lawyers, but that's our entrée to being industry lawyers. We want to look after every bit of legal work, that we can do well, that comes from these clients. It is second nature for us to look for opportunities to help with tax, labour law, IP and so on. It is just as important to be able to say to our clients that they can be looked after in those areas. We want to be our clients' lawyers, not their fund formation or technical FSA lawyers."

Rob Helm, the former head of the practice, is based in Washington DC. He says, "The funds are now beginning to take more of the role played by private equity funds, and we aspire to advise managers in all aspects of their operations from transactional work to litigation."

To that end, Dechert must also further expand internationally. Simmons & Simmons can boast much broader continental coverage, as well as more historical strength in general corporate and M&A work across Europe.

At the moment, Dechert's continental presence lacks anything in Southern Europe, or in Ireland. An office in Dublin is clearly on the agenda, though not yet in the planning stage.

Asia is another gaping hole in the network. Cadby at Liberty Ermitage says, "We are going to be looking at more deals in Asia,and seeding hedge fund managers out there. I suspect that is not something Dechert can help us with, I'm pretty sure their reach doesn't extend to that region."

The firm currently works alongside a local law firm, Deacons, to service the work. But Astleford concedes an Asian presence is needed. "We need to be in Asia, there's no doubt about that," he says. "Whether the first office is Hong Kong, Singapore or Tokyo, that's to be decided, but I think we need to be in one or all three of those places in the next five years."

Finding the people isn't easy, not least because the firm has always tried to add lawyers that have some experience of working in the industry. Keeping the best lawyers is also hard, particularly as the hedge funds build up their own in-house legal teams. Having grown to 27 lawyers from nothing, the department now loses an average of three lawyers a year, which is a retention rate roughly on a par with the rest of the legal industry, though it sees a disproportionate number going in-house. Remuneration levels in the funds can significantly outstrip what is on offer at the law firms, though Dechert aims to pay more than the Magic Circle law firms do, and to offer associates more client exposure early on in their careers.

Having started out early, and grown up with the hedge fund industry, Dechert now faces an enormous challenge to stay ahead amongst some aggressive rival law firms. As Helm in the US puts it, "There are a lot of other US law firms opening in London. We are very flattered that they think we had a good business model. We think we are still way ahead of the game, because we have also have very good offices on the Continent."

Astleford remains confident that the industry will go from strength to strength, and that the transatlantic offering will be crucial for clients.

"The hedge fund industry is trying to give an absolute return," Astleford says. "There will be a greater and greater investor demand for that type of service, and that will carry the industry through. If you read in the press about too many people chasing too few returns, that's true, but it misses the point. The investors actually want to get more out than they put in, and the equity world doesn't try to do that. The hedge funds have as a cross-section done better than the traditional funds in terms of performance and volatility, and I think this industry will grow and grow."

Martin concludes, "If you had asked me five years ago, what are amongst the most important attributes of a funds lawyer, I would have said a good corporate grounding, tax grounding, to have worked in-house, and to have done capital markets work. Now I would without hesitation add derivatives and securitisation to that list."

The transatlantic axis is all-important, and Dechert's devotion to the alternative investment funds market is firmly entrenched.

They will nevertheless have to work hard to stay out in front, particularly as the larger law firms spot the opportunities, and the funds branch into ever-more complex legal disciplines.